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The Election Trade: How to Trade the U.S. Elections

Updated: Dec 21, 2020



 

Main Idea:

Stimulus appears to be the dominant force in the optimism that is running through the markets. The correlation between stimulus and market optimism has been getting increasingly stronger and is expected to continue; until the markets are no longer dependent on cheap credit provided by the Central Banks. Monetary and fiscal stimulus both seem to have a positive effect on equity/ commodity prices, though they both have a different lag as to when these changes are seen in the market.


Assumptions we are operating under:

1) The markets have become dependent on stimulus to drive significant price changes.

2) Markets prefer certainty above all else. It doesn't matter who wins as long as the investors in the markets can make long term bets. Certainty is key for optimistic markets.

3) Stimulus will be a bigger driver for the direction and intensity of markets then the results of the elections themselves.

4) Regardless of who wins, the new president will announce stimulus plans and this will have a positive affect on the markets.

5) More stimulus and QE = Bearish dollar/ bullish asset prices.


Prediction: If there is no stimulus bill passed then the markets will not have enough momentum to continue higher until the economy re-stabilizes from the pandemic. Once stimulus is announced, the markets will react according to the existing trend and surge higher on the hopes that the stimulus finds its way back into markets. Between corporations using cheap loans to buy back stock, retail traders dumping their stimulus checks into their investment accounts, and pension flows returning from payroll (401k investments), the stimulus should have a positive effect on asset prices across the board.


Currency Prediction: Stimulus will likely be implemented after the the elections so before the stimulus we can expect a bullish dollar. After stimulus is announced we can see a bearish push in the dollar as the supply of dollars begins to outweigh the demand. A bullish dollar (No stimulus) scenario is negative for equities and commodities and bullish all USD crosses. After the election we can expect a stimulus package/ infrastructure bill that will stimulate trillions into the markets, making the equity markets boost and making commodity prices rebound to new highs.


Pre election = Bullish dollar, bearish equity, bearish Gold, sideways oil, bullish Euro. Expect sharp retracements before the stimulus.

Post Election= Bearish dollar, bullish indices, bullish Gold, Bullish Oil. Expect new highs from he markets after the certainty is back.

 

Key Words to Know:

- Stimulus: An incentive that rouses activity or energy in something.

- Monetary Policy: A function of the Central Bank that allows for the control of the money supply. These powers are exercised through the control of the interest rate (cost of money) and the supply of money in the open markets.

- Monetary stimulus: The facility by which the Central Bank can provide liquidity to the markets. This has been recently done through Q.E. (explained in previous articles). The central bank can provide its member banks with the necessary credit it needs.

- Fiscal Stimulus: Unlike monetary, this form of stimulus is the responsibility of the federal government (Legislative body). Fiscal stimulus allows direct aid to individual corporations/citizens in times of economic need. This stimulates the economy because consumers use this

- Blue Sweep: A blue sweep or democratic sweep would mean that the democratic party wins the presidency as well as the legislative majority. This indicates a higher likelihood of the president being able to push their economic policy with ease.

- Contested election: A scenario where the outcome of the presidency is challenged due to questions about the legitimacy of voting methods. This scenario has been seen before in the 200 election involving bush and Al Gore where the results were delayed for several weeks and the markets suffered a 5% decline during that uncertainty.


 

Pre, During, Post- Election outcomes

Pre-Election scenarios:


Scenario 1 (Most Likely): No stimulus deal is reached and the Federal reserve refuses to add more monetary stimulus. This will mean that pre-election markets will give us a bullish dollar, bearish equities, and bearish commodities. Investors will sell of their risk assets in order to get dollars if a shortage occurs. They will then use this cash to buy up assets at discounted prices.



Scenario 2: A stimulus deal is reached before the election. If this occurs then we can expect to see a bullish rally in equities and a sharp decline in the value of the dollar. The optimism of stimulus will make smart-money investors buy equites in the hopes that the stimulus money will find its way into the market and pump up their positions. Dollars will be abundant in the open market so the supply should outweigh the demand.

 

During-Election scenarios:


Scenario 1 (Most likely): Our base case is that power will transfer smoothly and that the results of the election will be known on election day. If Biden wins then the markets may have a knee-jerk reaction to sell off but it will be short lived when he announces stimulus plans and infrastructure, If Trump wins we might have an immediate bullish reaction, and then a steady rising equity market as certainty returns to the markets. If the possibility for a blue sweep is imminent then the market will have an immediate negative reaction and then rebound once stimulus is announced.


Scenario 2: Another scenario that's been floating around is the possibility of a contested election result. This will occur if the Trump presidency does not accept the election result and seeks a recount. This will prove to be the worst scenario for markets as all markets crave certainty. Not knowing who the next president is will create a lot of short term volatility as speculators make their bets in the market. After the result we can expect to see a short term sell off and then a massive rally in equities as the certainty comes back.

 

Post-Election scenarios:


Scenario 1 (Most likely): Biden wins in an uncontested election. The markets will have an immediate negative reaction since his policies seek to hurt corporate earnings, which is a key driver of the economy, After the initial shock the administration will announce a Trillion dollar infrastructure plan and will announce a new round of stimulus to jump start the economy. The certainty of the outcome combined with the announcement will be the catalyst for the equity markets rallying.


Scenario 2: Trump wins in an uncontested election. If trump is set to win the election then we may see markets have a short term negative reaction as civil unrest returns in protest. After the initial unrest the markets will be discounted and the announcement of stimulus/ infrastructure plans will boost the optimism for consumer/corporate markets. Once stimulus is announced we should see a decline in the dollar and a rise in the stock market.


Scenario 3: There is a contested election result and the markets punish the uncertainty by selling off their risk assets and going to safe havens such as Gold, bitcoin, and maybe the dollar. During the contested period the markets will sell off in order to get dollars and will likey be held in cash to invest after the markets calm down. This excess cash on the sidelines will create a perfect storm for a rally as soon as the market is ready.


Scenario 4: Biden wins in a blue (democratic) sweep. This will almost surely be negative for asset markets because it will be seen as Biden having full authority to implement his harmful tax policy. The markets will see an initial reaction to the sweep. Once stimulus is agreed on then the Equity markets will rally and create new highs.


 

In conclusion:


We have a very important election that will determine the economic direction of the country. In the midst of a global pandemic and recessions caused by lockdowns, we have an election that is surrounded by an stigma of uncertainty. The biggest factors to watch out for in order to best catch high volume swings are:


1) Stimulus talks in the legislative branch. Don't trade the news of potential deals but instead wait for an announcement of a legitimate agreement. Laws are real, rumor is not.

2) Federal Reserve indicating the need for more monetary stimulus and resuming their money printing (Q.E.) facility. This will cause the dollar to weaken and will positively affect asset prices.

3) Election night results and the potential for a contested election. If the election is contested then allow the equity market uncertainty to play in and look to enter at discounted prices.


The name of the game is certainty and stimulus. Short dollar and Long equities will be the trade once the government announces new stimulus. Good luck and safe trading everyone.

 

Disclaimer: This article is the result of the analysis carried out by analysts associated with ChartAddicts. The article does not purport to represent the views or the official policy of ChartAddicts. This is not investment advice.

 

Pipstradamus

ChartAddicts Analysis Team

10.19.2020


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